What is restricted cash?

Definition

Restricted cash is money that is still at the bank but cannot be used for ordinary bills. On the books, this is an account in current assets when the restriction lifts within a year, and it is kept off the spendable cash line.

It sits on the Balance Sheet, usually just below cash and cash equivalents. It is still one of the assets, but it is not fuel for payroll this week.

The restriction usually comes from a lender, a landlord, or a customer contract. A compensating balance, a construction escrow, and a pledged certificate of deposit are common forms.

Self-imposed savings is not the same thing. If you can still write a check without breaking a legal or contractual limit, the cash is not restricted.

Where it shows up

Balance Sheet: Located in the current assets section, below cash and cash equivalents.

P&L: Related to loan covenants, not to day-to-day sales.

Cash flow: Increases in this account, reported cash from financing activities decreases.

See also: Cash And Cash Equivalents · Covenant · Liquidity

When you look at your Balance Sheet, restricted cash is listed in the current assets section when the restriction is short-term. If the pledge lasts more than a year, the amount moves down with the non-current assets.

A large restricted balance can make the company look cash-rich if you leave it inside the spendable total. Readers will overstate how many bills you can pay.

The profit and loss statement does not list this account. Loan covenants that require the pledge live in the loan agreement, not in day-to-day sales.

On the Statement of Cash Flows, moving spendable cash into a restricted account is usually a financing outflow. The total dollars at the bank may not change, but the spendable dollars did.

How it works

The amount gets in when you set money aside or when a lender requires a pledge. The typical entry moves dollars out of the operating account and into this account.

The amount stays until the restriction lifts. That might be loan payoff, a covenant test you pass, or the end of an escrow period.

You still reconcile it. The bank statement for that separate account should match the book, even though you cannot spend the funds.

Do not pay vendors from this account. If you do, you may break a covenant and turn a Balance Sheet line into a default.

Interest earned on the pledged account may be yours or may be added to the pledge. Read the loan agreement before you treat the interest as spendable.

Classify it as current only when you expect the restriction to lift within a year. A five-year compensating balance is not a current asset.

Do not net this balance against the related loan. The cash is an asset, the loan is a liability, and both should remain visible.

If only part of a pledge expires this year, split the line. The current piece stays with current assets; the rest sits with the long-term items.

A borrowing-base facility can require a cash reserve when receivables dip. The reserve is still restricted until the lender releases it, even if the operating account looks fine the next day.

Example

An equipment rental yard borrows on a term loan. The lender requires $10,000 to stay pledged in a separate bank account for as long as the loan is outstanding.

The yard moves $10,000 out of checking. It records:

Debit: Restricted cash $10,000

Credit: Cash $10,000

Spendable cash falls by $10,000, and restricted cash rises by $10,000. Total assets do not change; cash from financing activities on the Statement of Cash Flows falls because spendable cash was pledged.

The yard cannot use that $10,000 to buy a skid steer. It still belongs to the business, but the lender has first claim on it.

Common mix-ups

Restricted cash is not cash and cash equivalents. If you cannot pay rent from it, it does not belong in the spendable total.

A rainy-day savings account you chose to leave alone is not restricted. Restriction comes from a contract or a law, not from a personal goal.

A security deposit you hold for a customer is not your restricted cash. That is often a liability, because the money is theirs to get back.

Related terms

• Cash And Cash Equivalents: Bank balances and near-cash holdings that can be spent immediately.
• Covenant: A condition in a loan agreement the borrower must keep meeting.
• Security Deposits: Cash held by a landlord or vendor that will be returned later.
• Line Of Credit: A revolving loan the business can draw on and repay as cash needs change.
• Balance Sheet: A statement showing what a business owns, what it owes, and what is left for owners at a single point in time.
• Liquidity: How readily the business can cover near-term obligations with available cash.
• Account Reconciliation: Proving that a ledger balance agrees to independent support.
• Borrowing Base: The pool of receivables and inventory that determines how much a lender will advance.